As it’s the end of the year, we thought it would be a good idea to recap the decisions reached by the FASB and IASB about lease accounting. Here is a quick summary:
All LEASES ON BALANCE SHEET:
Lessees will be required to recognize assets and liabilities arising from all leases, with some exceptions. Their rational is that by signing a lease, the lessee has an obligation to make payments (a liability) and in exchange for those payments, the lessee is receiving the right to use a specified asset (an ROU asset). All leases will now be capitalized.
INCOME STATEMENT DOES NOT CHANGE (FASB):
The FASB has tentatively decided to stick with the existing distinction between operating and capital leases. Although both would be capitalized on the balance sheet, there would be no change to a lessee’s income statement.
The effect of an operating lease – now called a Type B lease – on the income statement would still be straight-line expense (the same amount each year), while capital leases – now called Type A leases – will continue to be front-loaded (higher expense in the beginning which decreases as payments are made).
The IASB, on the other hand, has tentatively chosen a single model. All leases would be treated as capital leases, and the effect on the income statement would be front-loaded for all leases.
DEFINITION OF A LEASE:
There is really no change in what constitutes a lease under the existing and the proposed rules. That said, under existing standards, the accounting for operating leases and service contracts is similar. Under the proposed rules, this will change.
Therefore, it becomes vital to understand the distinction between a lease and a service contract because that distinction would determine whether a lessee recognizes assets and liabilities.
MEASUREMENT OF LEASE ASSETS AND LIABILITIES
A lessee would measure the lease liabilities as the present value of the lease payments. The lease asset is the lease liability plus direct costs related the lease and less any incentives received from the lessor. Contingent rentals and option payments would be excluded from the calculations.
There are no changes to lessor accounting.
Next for the boards to address is transition and disclosures. Based on my communications with the FASB, there are going to be significant changes to the transition rules proposed in the 2013 Re-Exposure draft. Please leave comments below if you have any.